Thursday, May 20, 2010

Mergers & Acquisitions
Waning Star of the Air Struggles as Solo Act

May 20, 2010, 9:07 am — Updated: 12:30 pm -->

American Airlines, for decades the industry’s leader, been backed into a corner?

Delta Air Lines’ merger with Northwest Airlines two years ago knocked American to No. 2. Now, the proposed union between United and Continental Airlines would push American down to third, Jad Mouawad reports in The New York Times.

All this leaves American with some of the industry’s highest costs, as well as poor labor relations and a smaller network of routes. Some analysts contend that the airline has few options other than merging with
US Airways, which was left out when United decided to go for Continental. Others see American as the “Ugly Betty” of the industry, an airline struggling to find a suitable partner.

“American has been used to cruising at 55 miles per hour ahead of everyone, but now two competitors that are very well capitalized, with much larger networks, have suddenly passed them over,” said Hunter K. Keay, an airline analyst at Stifel Nicolaus. “The critical question is whether this is not time for American to speed up.”

American’s executives counter that they will not be forced into making a rash move, nor into blindly following the industry’s matchmaking trend. Instead, they argue that being a little smaller will allow their airline to be more nimble.

“We are not ceding anything to anyone, but we are trying to build something that we believe will be able to be profitable,” Gerard J. Arpey, the airline’s chairman and chief executive, said in a recent interview at its headquarters in Fort Worth.

Rather than trying to compete everywhere with everyone, American seeks to focus on five major cities in the United States — Dallas, Chicago, Los Angeles, Miami and New York. It is more important to be big in cities that account for a significant portion of the nation’s air travel, its executives reason, instead of spreading itself too thinly.

Overseas, American is betting on its international alliance, Oneworld, to expand its reach in Europe and Asia, because of partnerships with
British Airways and Japan Airlines.

“Our strategy is not driven by ranking but by making sure we have a network and a group of partners around the world that will be as strong — if not as big,” Mr. Arpey said.

By most measures, American remains a formidable airline. It flies about 286,000 people each day, employs 87,000 people, and along with its regional carrier, American Eagle, operates around 3,400 daily flights to 250 cities and 40 countries.

At its shareholders’ meeting on Wednesday, American said it expected that the Oneworld alliance would mean $500 million for
AMR, the airline’s parent. It also has an impressive history, introducing coast-to-coast jet service in the 1950s, pioneering electronic reservations in the ’60s and offering the first major frequent-flier program in the ’80s.

But the last decade has been brutal for American and the rest of the industry. Airlines suffered from terrorist attacks, global pandemics and recessions that have curtailed air travel. Oil prices soared. For every dollar-a-barrel increase in the price of oil, American’s annual fuel costs increased by $70 million. Fares, meanwhile, have been kept in check because of pressure from low-cost competitors.

As a result, American was profitable for only three of the last 10 years. It racked up losses of $10 billion over that period.

But critics on Wall Street and among the company’s unions say they doubt the company can turn its fortunes around. They say American’s management is too timid and unwilling to cut unprofitable routes, and it has failed to rein in costs, among the highest in the industry. The United-Continental deal is just the latest blow.

Lloyd Hill, the head of American’s pilots union, the
Allied Pilots Association, said the company suffered from a “leadership vacuum.” And in a conference call last month, one Wall Street analyst publicly dressed down the company’s executives for a lack of passion.

Shares of AMR are down 9 percent this year, the worst performance by a major airline and well below the sector’s average gain of 13 percent. By contrast, shares of UAL, United’s parent, have gained 46 percent; Delta is up 20 percent in the same period.

Bob McAdoo, a senior airline analyst at Avondale Partners, said that American lags its peers. “Everybody else has seen improvements in recent years, and American hasn’t really done much of that,” he said.

American is one of only three major carriers that have never filed for bankruptcy, along with
Southwest Airlines and Alaska Airlines. As a result, the company is hobbled with much higher costs than its competitors, most of which have used bankruptcy proceedings to rewrite their labor contracts and airplane leases, terminate pensions and health benefits, and restructure their debt. If it had contracts similar to Delta’s or Continental’s, the company estimates its expenses would be $600 million lower each year.

Mr. Arpey defends his record. “I still believe in principles in a business that will often push you to compromise your principles,” he said. “I believe in the long run it will serve our institution and our stakeholders that we honored our commitment to our creditors, funded our pension plans and have done our very best to do everything consensually. But that remains to be seen.”

The company anticipates that once other airlines start to renegotiate their contracts, labor costs will rise through the industry, narrowing American’s cost disadvantage. That, in turn, may put more pressure on rival airlines to increase fares.

Michael Boyd, an aviation consultant, said American had a strong domestic network and dominant routes to South America. He also praised the company’s decision to buy new fuel-efficient planes and ground less efficient ones.

“All the talk where they have to find a domestic partner, and where they have to be the biggest, does not make a lot of sense,” Mr. Boyd said. “Remember, the brontosaurus was a really big dinosaur.”

While American has not ruled out a merger, its executives have said on many occasions that they feel no need to consolidate. Instead, the airline is counting on its international alliance with Oneworld to catch up with Delta and United, which have been able to cash in on their competing alliances for years.

American’s application for antitrust immunity for a joint venture across the Atlantic with British Airways, first submitted 13 years ago, was granted this year by the Transportation Department, and European authorities are also expected to give their green light this year.

American hopes to replicate its major cities strategy in the United States by focusing on a handful of major global hubs — including London and Tokyo.

“If you spread yourself too thinly, you win fewer battles,” said Dan Garton, American’s chief marketing officer. He said that it was more valuable for American to add flights to London and expand its depth of service than to stretch itself to smaller markets like Venice or Kiev. “We try to fly to markets that have the biggest bang for our bucks,” he said.

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